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Geithner on regulating financial markets

The federal government is close to “winding down” the $700 billion financial bailout program, said U.S. Treasury Secretary Tim Geithner, testifying before the Senate Agriculture Committee Dec. 2.

Although he offered no specifics, the statement will likely please legislators unhappy with the bailout.

Geithner also agreed with lawmakers calling for greater transparency and oversight for the “global, unregulated $600 trillion derivatives market.”

(For Geithner’s prepared statement, see

The Obama administration has “proposed to establish a new Consumer Financial Protection Agency with the power to establish and enforce protections for consumers across a wide array of financial products,” said Geithner.

“We have proposed to extend the scope of prudential regulation beyond the traditional banking sector to cover all financial firms whose failure could pose a threat to financial stability.

“We have proposed to put in place more conservative constraints on risk taking: tougher capital and liquidity requirements for financial institutions, and stronger cushions in the critical market infrastructure.

“And we have called for standards on our largest and most interconnected financial firms to be substantially higher than those on other firms.”


Despite repeated pledges of politicians and government entities to work together, sticking points remain over market oversight legislation.

Since the financial crisis of last fall, Arkansas Sen. Blanche Lincoln, chairman of the committee, said she’s “spent a considerable amount of time talking to folks in Arkansas. I’ve heard from people from all walks of life about how the economic downturn has impacted them. I’ve talked with farmers, small-business owners, wage-earners, people from the city and country, single parents, people who have lost their jobs and are looking for work, and people who still have their jobs but who have been stung by the rising prices of commodities and have to make choices about putting food on the table or gas in the tank.”

Following the conversations, Lincoln’s take-away was that “business as usual is simply not acceptable any more. People are hurting and we need to find answers. We also must rebuild the confidence of the American people and the investors out there who are our constituents.”

The nation’s identity hangs in the balance, said Lincoln. The United States is not “a nation of spendthrifts, or of fraudsters, or of sharp dealers. We didn’t build our reputation as the premier leader in global financial markets by cutting corners, engaging in risky behaviors, or developing business strategies that are intended in large part to avoid the positive restraints of regulatory oversight.”

Yet “somehow, somewhere along the way, we lost our compass” said Lincoln, pointing at financial innovation and rampant deregulation as chief culprits in the ongoing financial crisis.

The financial market meltdown “stemmed primarily from two problems: inadequate federal oversight of significant sectors of our financial system — particularly OTC derivatives trading — combined with a failure to use existing authorities to their fullest extent. We now have the responsibility to ensure that market regulators have all the tools they need, and to charge them with the mandate to use these tools.”


Georgia Sen. Saxby Chambliss, ranking member on the committee, continued to push points he’s made in previous hearings. In setting up new regulations, “it is imperative we take the right kind of action — and I emphasize ‘the right kind’ — to make sure we put tools in the hands of our regulators to allow them to do the job making sure what happened last year doesn’t happen again.”

During the last Senate Agriculture Committee hearing ( on Nov. 18, “we heard from a number of entities that use derivatives to manage risk in their everyday course of business,” said Chambliss.

“They were somewhat critical of Treasury’s proposal requiring them to clear standardized transactions. … Many end-users have told me (such clearing) would add considerable costs that would likely be passed along to consumers or, perhaps, prevent their businesses from using swaps as a risk management tool altogether.”

The same end-users encouraged increased transparency for market deals “which is certainly our number one goal. They seemed perfectly willing to endure any additional administrative burden that may be presented by such reporting and record-keeping.

“Clearly, the regulator needs more data in order to view and police the entire marketplace. But I’m not sure the lesson of the recent market meltdown warrants increased costs to businesses that had little, if anything, to do with creating this situation.”


Geithner said while designing over-the-counter (OTC) derivative market reforms, the Obama administration has four broad objectives:

• Preventing activities in the OTC derivative markets from posing risk to the stability of the financial system.

• Promoting efficiency and transparency of the OTC derivative markets.

• Preventing market manipulation, fraud, and other abuses.

• Protecting consumers and investors by ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties.

“Our detailed legislative proposal, which is now working its way through Congress, provides a comprehensive approach to derivatives regulation that meets the core objectives set forth above,” said Geithner.

“The plan provides for strong regulation and transparency for all OTC derivative transactions, regardless of the reference asset, and regardless of whether the derivative is customized or standardized.

“In addition, our plan provides for strong prudential and business conduct supervision and regulation of all OTC derivative dealers and other major participants in the OTC derivative markets.”


Following the market collapse of 2008, the American taxpayer propped up the global economy and “footed the bill for Wall Street’s poor choices and failure of government oversight,” Lincoln told Geithner. “But they still haven’t gotten the regulatory reform. And I have to tell you (the issue) hasn’t faded — not in states like Arkansas where people have a real sense of how difficult this economy is.”

Regarding foreign exchange transactions, Lincoln pointed out the Commodity Futures Trading Commission (CFTC) has “serious concerns about the exclusion of foreign exchange swaps or forwards” in the Obama administration’s proposal.

And that “those exclusions will simply be used to evade regulation. Frankly, given how we’ve seen sharp operators in derivative markets use this kind of loophole to get around federal regulation, I can understand their concern. Why shouldn’t we close this loophole?”

Geithner admitted that concern is legitimate. However, “there are aspects of these markets where for very important reasons we might (need) a slightly different approach. The important thing is not to allow those carefully crafted exceptions to undermine the basic protections … to become the device for evading protections.

“I’m confident we’ll work this out and come to a place where the CFTC, the Fed and Treasury will together find the right balance. We’re not quite there yet.”

Foreign exchange markets “are different,” he continued. “They don’t present the same set of risks and there is an elaborate framework in place already … to limit settlement risks and others. Those markets work quite well.”

Geithner and colleagues have pushed for moving market transactions into clearinghouses to reduce systemic risk, said Chambliss. “While that might make sense for systemically risky institutions, you’re certainly aware that many end-users who aren’t contributing to the risk … have asked for an exemption for any such mandate.”

Such transactions are “a very small percentage” of the overall swaps market, said Chambliss — perhaps “only 15 percent.” If that is the case, “do we really need to force these transactions into a clearinghouse when we’d already be capturing the bulk of OTC swaps currently on the books? If so, how does this reduce systemic risk?”

The Senate and House have been “working to design a carefully crafted exception for a certain class of end-users that would protect their ability to hedge … without undermining the basic protections we’re trying to put in place for the entire system,” said Geithner.

“I’m not sure we’ve got the balance right, yet. But I think there will be a place for some carefully crafted, limited exception for non-financial end-users.”

If legislators aren’t careful, “we’ll over-regulate the U.S. markets and drive U.S. customers as well as foreign customers of U.S. institutions offshore,” warned Chambliss.

“There will be an … effort to secure additional regulations comparable from international markets. Where are we there? I’m not encouraged by some statements I’ve heard from some of our international partners on this.”

Chambliss’ worries are justified, said Geithner. “You’re right to be concerned about seeing the details — it’s all about the details. But at the basic level of objectives and core elements of the framework, I actually think there’s very broad consensus among the relevant authorities for the critical and major markets.”

Swaps and derivatives have been around for a while, pointed out Chambliss. “But there were new products created over the last several years that participated, to a great extent, in the meltdown last year.”

Moving forward, “we want to make sure regulators have the ability” to ensure any new financial products won’t cause similar problems. “That’s in the back of our minds and we want … a level of comfort … from every entity that has the potential to regulate these markets.”

Geithner: “I couldn’t agree more. To borrow a security metaphor used by generals: you can’t make this about fighting the last war. You have to make sure you … close the critical weaknesses in the current system but in a way that gives us all confidence that we’re preventing the next crisis.

“It will never be perfect. No system will be. But it needs to adapt more quickly so it doesn’t lag so far behind the growth in markets. Our system lagged way behind.”

The basic theory underpinning the Obama administration’s approach, said Geithner, “is to make sure the basic shock absorbers in the system — capital and margin — are much more conservatively designed and provide much thicker cushion against risk.”


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